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Welcome to our most recent Recommended List of Funds. This report contains our best fund ideas, asset mix suggestions and brief commentaries on a number of funds. We hope that you find this report to be helpful.
Additions
PH&N High Yield Bond Fund (RBF 6280 –Front End Units, RBF 4280 – Low Load Units) – It is almost like Christmas came early, with the announcement that the PH&N High Yield Bond Fund was reopening. This has long been my favourite high yield offering, but it has been closed to new investors since November 2010. With current market conditions, they felt it was possible to reopen the fund. However, according to RBC, there is only a limited amount of capacity, and they will not hesitate to close it again as that level approaches. It is widely expected the fund will be closed again within a few weeks, so if you want some, you had better act fast.
The fund focuses on medium quality corporate bonds, convertibles, and preferreds. At the end of August, 96% of its holdings were rated BB or lower. It can invest anywhere in the world, but currently about 37% is in Canada, 63% in the U.S. The U.S. allocation is up significantly from a year ago. The sector mix is based on the relative attractiveness based on their top down macro analysis. Once the sector mix is set, the managers conduct a fundamental analysis on a number of companies, looking at their free cash flow, and interest coverage ratios to determine quality. It is conservatively positioned with a duration of 2.5 years, well below the 3.8 years of a year ago. This positioning will allow it to hold up better than the broader bond market when rates move higher. Given the more conservative nature of the fund, performance can be a bit of a mixed bag compared with other high yield funds. It tends to lag in markets where high yield issues are rallying higher, yet holds up much better in periods of extreme uncertainty. Volatility is the lowest in the category, resulting in consistently above average risk adjusted returns. Another bonus is that it carries one of the lowest MERs in the category, even for the advisor sold units.
This has been one of my favourites in the fixed income space and I expect it to be for the foreseeable future. The only reason it has not been on my Recommended List in the past is that it has been closed to new investors. It is a great way to add high yield exposure in your portfolio without taking on huge risk. The only drawback is that it is likely to be closed again very soon as new assets flow into the fund.
IA Clarington Canadian Small Cap Fund (CCM 520 – Front End Units, CCM 521 – DSC Units) – It was a very tough decision to add this fund to the list. Not because it doesn’t belong here, but because it is a very similar fund to one that was already on the list – the CI Can-Am Small Cap Fund. Both are managed by QV Investors out of Calgary using a near identical process that looks for high quality businesses run by strong management teams that are trading at attractive valuations. Both funds are built on a bottom up basis, and tend to be fairly concentrated.
But they are also somewhat different, with the CI Can-Am Small Cap having more exposure to mid-cap names, and more than 22% invested in U.S. small cap stocks. It is this difference which ultimately tipped the scales towards the IA Clarington offering. In a recent conversation with manager Joe Jugovic, he indicated that valuations in the U.S. small and mid-cap space were less attractive than what is available with Canadian small caps. Looking at the valuation metrics of both portfolios confirmed this, with the P/E ratio, operating margins, expected earnings growth, and the debt ratios favouring the IA Clarington Canadian Small Cap. Looking forward, while short term momentum may still favour the U.S. small caps, the valuation story in Canada is more compelling mid to long term. Because of that, I opted to make the switch.
That said, I still believe that the CI Can-Am Small Cap is a great fund. If you hold it, and are comfortable with it, I would not suggest that you make an immediate change. Going forward, I believe the environment slightly favours the Canada focused IA Clarington Canadian Small Cap Fund.
Deletions
CI Can-Am Small Cap Corporate Class (CIG 6104 – Front End Units, CIG 6154 – DSC Units) – This is a case where I am removing a fund not because it is a bad fund, but because there is a substantially similar fund that I believe is slightly better positioned. This fund has more than 22% invested in U.S. small caps, which are at a point where valuations are cause for concern. Because of that, I removed the CI Can-Am Small Cap Fund from the list, and replaced it with the very similar IA Clarington Canadian Small Cap Fund. While both are managed in an identical fashion, the Clarington offering looks more compelling from a valuation standpoint, and as a result, made the substitution. I still believe the CI Can-Am Small Cap is a great fund, I just didn’t want to have two very similar funds on the Recommended List. If you hold the CI fund, and are comfortable with it, I would not suggest that you make an immediate change.
Renaissance Global Markets Fund (ATL 1029 – Front End Units, ATL 1873 – DSC Units) – I have been growing increasingly concerned about this fund for the past few quarters. Manager David Winters uses a fundamentally driven, deep value approach that looks for undervalued and distressed companies of any size, that are out of favour with the broader market that have strong prospects for a significant return.
The portfolio looks nothing like the benchmark, and neither does its performance. Unfortunately, recent performance has lagged by a significant margin, and the risk / reward metrics have continued to erode. The manager is taking steps to improve the outlook for the fund, taking advantage of the selloff in Asia to add to their holdings in the region, particularly Hong Kong. At the end of September, more than a quarter of the equity holdings were invested in Asia. Cash within the portfolio was sitting at nearly 13%.
While I believe that over the long term China is likely to return to solid growth, I’m not sure the risks of this fund continue to justify keeping it on my recommended list in the near term. Another factor in my decision is the fund is managed in a similar fashion to the Franklin Mutual Global Discovery Fund. Looking at the portfolio metrics of that fund leads me to favour it over this offering in the near term. Its holdings are more attractively valued on a number of criteria including Price to Earnings, Price to Book, and Price to Cash Flow. While its recent performance has been somewhat underwhelming, its risk reward characteristics have been improving. I continue to monitor that fund closely as well.
CI Global Health Sciences Corporate Class (CIG 201 – Front End Units, CIG 701 – DSC Units) – I have long been a believer in the health care story, and that hasn’t changed. What has changed is how I want to access the sector. The CI Global Health Sciences Fund had quite a run, however, the tide turned on it back in February when the entire sector sold off. However, while the other funds in the sector have made up their losses, this fund has continued to languish and the risk reward characteristics have eroded significantly. I am currently reviewing the other healthcare options and will determine which I believe to be the best way to play the sector. In the interim, I am removing the CI Global Health Sciences from the Recommended List, pending the outcome of my review.
Dynamic Global Real Estate Fund (DYN 085 – Front End Units, DYN 785 – DSC Units) – I had become increasingly concerned about the risk reward metrics of this fund for a few quarters now. While I don’t believe it to be a bad fund, I don’t believe it is the best in the category. It has struggled for a couple of years, on both an absolute and risk adjusted basis, and when I look at the metrics of the underlying portfolio, I don’t expect that there will be a rapid turnaround. Considering that, I removed it from the Recommended List, and will conduct a more thorough review of the other Real Estate Equity Funds available to determine if any of those should be added to the list.
Funds of Note
Dynamic Advantage Bond Fund (DYN 258 – Front End Units, DYN 688 – DSC Units) – Despite lagging the other picks in the quarter, and so far this year, I still believe that this will be a great bond fund to hold when rates finally do start to move higher. However, it is now starting to look like Central Banks, particularly the U.S. Federal Reserve and the Bank of Canada may be keeping their policy rates on hold for a quarter or two longer than many, myself included, had anticipated. Still, duration remains shorter than either the PH&N Total Return Bond Fund, or the TD Canadian Core Plus Bond Fund. The managers continue to favour corporate bonds over governments. They have also taken advantage of the recent selloff in the high yield market to increase their exposure on a tactical basis, meaning they expect to sell their holdings as spreads compress and valuations become extended. In this environment, I would expect this fund to underperform slightly, given its more conservative positioning. More conservative investors will likely want to invest in this fund, however those looking for a more balanced approach between risk and return will want to consider either the TD or PH&N offerings for the next few quarters.
Fidelity Canadian Large Cap Fund (FID 231 – Front End Units, FID 531 – DSC Units) – One of the things I like about this fund is manager Dan Dupont is disciplined and sticks to his value focused style. He runs a portfolio that looks nothing like its benchmark, and in a rarity for a Canadian focused fund, has no exposure to Canadian banks or golds, and is significantly underweight in energy. The result is a return stream that is also much different from the index, which helps explain why it has struggled to keep up with its peers so far this year, as energy and materials have been rallying sharply. However, when these sectors hit the skids in September, it was able to outperform both the index and the overwhelming majority of its peers. Over the long term, I believe that the value focused style will result in above average returns with lower risk. However, I also expect there to be periods where it dramatically underperforms. As a result, if you are at all uncomfortable with the potential for significant underperformance for a quarter or two, you may want to consider another fund that is more closely aligned with the index. However, if you are looking for the potential for above average risk adjusted returns, this is a fund that is definitely worthy of consideration.
Trimark Canadian Small Companies Fund (AIM 1683 – Front End Units, AIM 1681 – DSC Units) – I originally added this fund back to my Recommended List in March 2013 as a replacement for the Mawer managed BMO Guardian Enterprise Fund, which had just been capped. Now I find myself in a near identical situation, as Invesco recently announced that this fund would be closed to new investors effective October 8. It is a “soft cap”, meaning that those investors who already held the fund could add to their holdings. While it is unfortunate that one of the best small cap funds in the country is being capped, it really is in the best interest of the current investors for them to do so. The managers run a very concentrated, high conviction portfolio that is made up of the managers’ best 25 to 40 ideas. They are disciplined in their approach and will not make any investment that does not meet their strict quality and valuation criteria. This can result in significant cash balances, which at the end of September sat at more than 30%. If you hold this fund and it is appropriate for your portfolio, I would continue to do so. However, if you are looking for a high quality Canadian small cap offering, you will have to look elsewhere, with IA Clarington Canadian Small Cap (or the other QV managed funds CI Can-Am Small Cap, or NEI Ethical Special Equity), or the Sentry Small Mid Cap Income Fund being my picks.
Mackenzie Ivy Foreign Equity Fund (MFC 081 – Front End Units, MFC 611) – I have long said that this is the global equity fund you want to own when markets get volatile, and that point was driven home by recent market activity. Between September 1 and October 16, the MSCI World Index dropped by nearly 6% in Canadian dollar terms. During the same period, the Ivy Foreign Equity Fund dropped a little more than 3%, or roughly 56% of the downside movement of the market. This is in line with its historic average. The managers run a concentrated portfolio of high quality companies from around the world with strong balance sheets and excellent management teams that are trading at a reasonable valuation. They are very patient in their approach as evidenced by their low levels of portfolio turnover. For the most recent five year period, it has averaged less than 20% per year. With more volatility likely in the next few quarters, those investors looking for a way to gain global equity exposure with lower volatility will want to consider this offering. One warning, given the conservative nature, it is likely to lag in rising markets.
Dynamic Power Global Growth Class (DYN 014 – Front End Units, DYN 1714 – DSC Units) – The overwhelming majority of the time, I focus on funds that do a great job at managing volatility and protecting capital. This fund is definitely an exception to that, with a standard deviation that is nearly double the MSCI World Index, a beta that is well north of 1, and upside and downside capture ratios that will leave you shaking your head. Managed by Noah Blackstein, this is a concentrated portfolio of 20 to 30 companies from around the world that he believes to have the best growth prospects, strong earnings momentum and a history of upside earnings surprises. At the end of September, it had exposure to only three sectors; technology, consumer discretionary and healthcare. Tech names made up more than half the fund, and consumer names were 30%. Mr. Blackstein’s style is very active, with levels of portfolio turnover averaging more than 200% a year for the past five years. This approach is very successful when markets are rallying sharply higher, but it can be devastating when markets get hit. For example, in 2008, the MSCI World Index was down by nearly 30%, while this fund was down by 47%. It recovered nicely, gaining 30% in 2009, more than doubling the 13% rise in the index. So far this year, it has matched the performance of the index, but still finished easily in the top quartile. In October, it gained 6.76%, more than four times the 1.6% gain in the index. Obviously given the risk reward profile of this fund, it is definitely not for everybody. Nor should it be considered to be a core equity holding. Instead, I view this as a fund that should only be considered by those who have a risk tolerance that is well above average, and are comfortable with the potential of losing a big chunk of their money over a relatively short period of time. But if you can stomach the ride, the potential for outsized gains as we move into the last couple months of the year remains strong.